LAST TIME (in Part 1), you discovered why the banks should not be allowed to call the shots. And perhaps a couple more Case Studies will help to further explain that.
Let’s take a look at what happened “Kevin”
He was a very successful property investor who had an impressive portfolio, consisting of several residential and commercial properties.
Kevin was able to build this portfolio through a mixture of a good knowledge of the market, savvy negotiating skills, a high-income job with a resources company and, it has to be said, some luck in picking the trends.
Kevin’s problem was that he wanted to retire early — which is something someone of his net worth should easily be able to do. But he made one major mistake.
Being from the old school of investing, Kevin believed in establishing a relationship with his bank. And then, letting them handle all of his funding arrangements — so his entire portfolio was combined into one facility.
Kevin’s plan for retirement was to purchase a large high-yielding Commercial property, and live off its substantial positive cash flow.
To achieve this, he needed to use the equity available in one of his existing properties. But unfortunately, due to the global financial crisis, his bank had become increasingly conservative; and now saw his considerable borrowings as a risk.
Even though he had extremely low gearing (well under 50%), and his servicing capability was strong by any standards … the bank would neither allow further borrowings, nor release any of his properties as security.
As a result, Kevin is still working 70 hours a week — just to keep his bank happy.
And finally …
The last example of the pitfalls of Cross Collaterising concerns a pair of developers we’ll call “Anthony” and “John”.
These guys had been successful developers for over 15 years, with an impressive track record. They developed only around their local area, which was an up-market suburb in a major city.
Anthony and John’s strategy was to hold on to a couple of units in each development they completed, and maintain some debt.
Once again, their mistake in debt structuring did not surface until the GFC. Like most, their bank shied away from property development financing; plus the local market had dipped in price.
At the next annual review, their bank decided it wanted them to take their business elsewhere — for no other reason than that they were property developers.
This was clearly a tough time for Anthony and John, as they were about to begin their latest development — which had been predominantly pre-sold and contained a healthy profit margin.
Unfortunately, the dip in the market also meant that their LVR on existing debt was considered too high to refinance with another bank. And they were left in a position where the bank would only accept a full pay out. Their only option was to obtain a very expensive short-term solution with mezzanine facility, in order to extricate them from this situation.
Bottom-line: Hopefully, you can now see that having the proper Structure really does matter. And these examples show how not paying attention to this can really hurt you — irrespective of how well your investments made be performing.
Anyone looking to be active in Commercial property investing (or development) should consider the importance of their loan structure. And also, weigh this up against attractive pricing deals, which usually come with rather onerous strings attached.
All that’s required is some clear thinking, and the right advice from the outset.